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The summer reader’s guide to scenario planning

With new developments in risk modelling, increasing computer power and the advent of big data, scenario planning is increasingly in vogue.

One of the treats of the summer is assembling your beach reading list. Recently, The Economist’s book recommendations centered on the theme of futurology: science fiction, trend spotting and scenario planning. Scenarios seem to be increasingly in vogue. After all the advances of risk modelling in the last decades, this seems to be an acknowledgement that the human mind is still best at predicting the future, especially in a volatile, uncertain, complex and ambiguous (VUCA) world. But what is the secret of useful scenario planning?

An alternative to the probabilistic way

The traditional approach to uncertainty has been probabilistic: looking at a wide range of events, rather than individual ones. In many ways, this approach is showing its limits:

Probabilities are not well understood by decision-makers, or may be ignored because of a stakeholder’s short-term horizon.

Assigning probabilities to risks such as cyber or terrorism is questionable.

Climate change is altering many physical processes: historical data that most models are based on is introducing a bias. Some of our research at Newcastle looks into these issues of non-stationarity.

Return periods (for example a “100-year flood”) are still widely used, but are so prone to misunderstanding and misuse that they may already be antiquated. Climate change is clearly changing the odds for a number of natural phenomena (like heatwaves and tropical storms) while its impact on others (like windstorms) is still unclear.

Scenario planning breaks our ingrained habit of assuming that the past and the present are a good guide for the future.

Scenario planning uses alternative narratives about the future, many with improbable and radical twists, to develop future-proof strategies. A classic example of the power of scenario planning is the approach pioneered by Shell. When the 1973 oil crisis hit, Shell was better prepared than its competitors, because its management had already considered a comparable scenario.

It breaks our ingrained habit of assuming that the past and the present are a good guide for the future.

The reliance on storylines makes it a very powerful way to communicate potential risks and opportunities to human decision-makers, who aren’t always rational.

Storylines in particular have been advocated as a better way to provide actionable information, because storylines seek to improve risk awareness, as scenarios better correspond to how people perceive and respond to risk. This is also a driver behind cyber war-gaming, used to educate boardrooms on a risk that is as much human as technological.

Using quantitative modelling

It is even more effective when scenario testing is combined with quantitative modelling, as demonstrated by the work of the Cambridge Centre for Risk Studies (a Willis Research Network partner), whose tagline is “science in scenarios”. In the finance industry, this evolution, known as stress testing, is fast becoming the litmus test for the resilience of banks and insurers:

The library of Realistic Disaster Scenarios issued by Lloyd’s keeps growing, and is no longer confined to natural catastrophes, but features cyber and terrorism scenarios.

The Bank of England recently released updated stress tests for insurers, which explore impacts of cyber underwriting and climate change.

Stress tests are compatible with the use of catastrophe modelling, but often stretch the boundaries of existing models — in particular, no model can claim to fully consider the multiple impacts of climate change. So imagination (backed up by scientific research) comes into play to enhance those models, and come up with best estimates.

There are huge uncertainties for human-instigated disasters: for climate change, uncertainty in the medium to long-term is driven by the lack of clarity on which socio-economic transition path will be adopted in the next few years; and for cyber (as for terrorism), looking at past activity is not the best way to understand future capabilities and intentions.

There are some final conclusions before you start buying books or downloading them to your Kindle. The following tips may help you prepare that summer reading list:

Marvel at the progress of risk modelling, but don’t rely entirely on computers to prepare for the future — using scenario planning is a good complementary activity.

Beware of a return period — like supernumerary decimal places, they may give a false sense of accuracy in predicting the future.

When designing scenarios, make sure you assemble multi-disciplinary, diverse teams from across your organization. This is the approach that our geopolitical team takes, and it reduces the possibility of blind spots.

Read about future scenarios considered in adjacent industries (Shell’s Sky scenario), published by governmental bodies or intergovernmental organizations: the U.K.’s Development, Concepts and Doctrine Centre (DCDC) publishes its Global Strategic Trends looking out to 2050 in 282 pages (or you can watch the condensed 4 min video version); the World Economic Forum is exploring the future of work in eight scenarios.

You may need a few long, hot, climate change-influenced summers to read completely into the subject, but as Shell found back in the seventies, even a little knowledge may yet prove to be worth its weight in gold when a crisis hits.